Individual 401k Plans Improvements

Even though being
single is not the most pleasant thing as regards your personal life, think of
the advantages that this status gives you in terms of financial conditions. The
most obvious example is the retirement-savings field.

The new pension
reforms that were established by the Economic Growth and Tax Relief
Reconciliation Act in 2001, makes it possible for self-employed to allocate
more money to their pension funds. This in turn gives a comparative advantage
relative to the regular retirement plans like Keogh and the Simple Employee
Pensions. This was caused by the increase of the deduction limits that can be
contributed.

Micro plans
(single-participant 401ks) are viewed as the most fast developing fields of the
defined-contribution market. What made 401k plans an attractive investment
destination is the ability of self-employed to make higher contributions.
Before the implementation of the EGTRRA, which provided for this opportunity,
employees were allowed to contribute to regular 401ks but, didn't have the
sufficient motivation to do so.

Having realized the
huge attraction that was created as a result of the new regulations, many
financial entities, such as fund companies and insurance companies, grabbed the
opportunity and launched 401ks for sole proprietors. Due to the immerged high
demand, the number of companies that offered this type of retirement plans
increased significantly, making it hard to find one that doesn't offer such a 401k
plan.

Another trend that is
observed is the huge percentage of rollovers to individual 401ks due to the new
opportunities. The investors truly realize the benefits they gain from them and
transfer their resources.

Before the implementation
of the EGTRR, the employee's salary deferral and the employer's contribution
were included in the total deductible contributions to the 401(k), limiting it
to 15% of the total compensation. This amount could not exceed $170,000. Under
the new pension regulations the contributions' amount is significantly
increased amounting to 25% of total compensation, but not exceeding $200,000.

The solo 401k plan
provides the employees with the possibility of contributing a salary deferral
in addition to a profit sharing contribution. As compared to the Keogh, the
latter allowed only for profit-sharing contributions. In both cases the
contributions made throughout the year cannot exceed $40,000.

The good news is that
under the new reforms, an employee working for a small business enjoys the same
financial status as one working for a large company with regards to retirement
plan contributions.

In order to feel the
difference imagine you have an annual salary of $40,000. You can make 25% of
the compensation in the form of contribution to a profit-sharing plan, which
amounts to $10,000. You should add $11,000 which represents the maximum amount
for 2002 for 401k plans. Thus your overall yearly contribution is $21,000.
There is a catch-up contribution that can be made by those at the age of 50 or
above, which amounts to $1,000 and continuously increases by $1,000 until the
year 2006. On the other hand, if you are under the conditions of a regular
profit-sharing plan, you will be able to contribute as little as $15,000.

There is no difference
in the contribution limits experienced under the conditions of a traditional
profit-sharing plan and a single-participant 401 (k) plan. But this is only in
case your annual salary is at least $160,000. Thus, you are allowed 25% of the
compensation.

Tax Implications

The bad news is that
these increases have some tax implications. You are subject to Social Security
taxes on the deferred contributions. On the other hand, your employer is not
obliged to pay any taxes concerning contributions made. The tax percentage is
paid by both employer and employee, but since you are self-employed you should
provide for both parts.

The old age, survivor
and disability components are included in the Social Security tax, which
amounts to 6.20% and is limited to $84,900. On the other hand, there is no
limit on the Medicare portion, which is owed on all wages and is 1.45%. As a
result, self-employed are liable to 15.30% Social Security tax on the salary
deferrals they make.

Net Earnings Calculations

The new regulation
requires a different approach about the way self-employed should calculate
their compensation.

The logic behind the
establishment of a 20% limit to the contributions made from the gross income is
that the self-employee's net earnings and the contributions made are dependant
on each other.

Conclusion

Despite the existence
of some negative aspects, it is still worth for the self-employed to contribute
to a 401k plan. The many offers of single-participant 401k plans differ from
one another in their costs and investment options. It has been calculated that
the average cost to invest in a 401k is approximately 0.76% of assets. However,
most single-participant 401k plans tend to prefer retail shares, which may
increase the expenses. Another issue that should be considered is paperwork.
Many companies provide the option of self-directed brokerage or an automated
administrative feature. So, consult with the company whether it does provide
these services.